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3 Purpose of This Presentation zTo acquaint you, the audience, with the basic concepts of LMP. zThe limited timeframe of this presentation means that it cannot impart enough knowledge to allow the audience to go forth and immediately participate in an LMP market. zThis presentation is not intended to advocate LMP, nor is it intended to oppose it.

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4 What is LMP? zTechnically speaking, LMP is a voluntary, bid-based, security-constrained, economic dispatch market that determines energy and transmission congestion prices at specific points based on marginal generation costs. zMore simply stated, LMP is a computational model that determines optimal generation unit dispatch as well as locational energy and transmission congestion prices. zLMP was developed by Dr. William Hogan, originally for use by the Pennsylvania-New Jersey-Maryland (PJM) ISO.

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5 LMP Basics zBefore we proceed, an explanation of three terms: yThe term constraint is used in this presentation to signify an imminent violation of a transmission lines physical or contractual limitations. yTransmission congestion is created by a constraint, and the term is used to signify any instance where the lowest-bid generator cannot be dispatched in economic merit order to meet load (and thus another higher-bid generator must be redispatched in out-of-merit order to meet that load). yThe term node is used to signify generation and/or transmission facilities that reside within a given location and have a relatively insignificant impedance. Because the impedance within a node is essentially zero, a generator located in a given node can supply a load at the same node with no impact to the transmission system.

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6 LMP Basics zToday, integrated utilities: yDetermine generation dispatch based on unit availability and operating costs; and yGeneration is redispatched in order to accommodate transmission constraints. yAll applicable customers on the grid pay an average energy rate, with no direct assignment of the costs of transmission congestion (i.e., those costs are socialized).

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7 LMP Basics zLMP is essentially the same as today, but: yGenerator offer prices (generally referred to as bids) are substituted for operating cost to determine unit dispatch. yAll customers at a specific point on the grid pay the price of the generator that is dispatched to serve the next MW of load at that point, as affected by local bids and transmission congestion. yIn effect, costs for any transmission congestion are directly assigned to customers within the specific location served by the constrained transmission line(s). zAn LMP energy market is a spot-based market and does not apply to bilateral contracts (although parties to bilateral contracts will still pay transmission congestion costs).

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8 LMP Basics zLMPs intended purpose is to determine the delivered energy price at a specific location by calculating and accounting for the relevant energy and transmission congestion prices. zGenerally, LMP determines an energy price for each electrical node on the grid as well as the transmission congestion price (if any) to serve that node. zFor the above reason, LMP is often referred to as nodal pricing.

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9 = LMP + Cost of Losses* The locational marginal price at a specific location is the sum of the cost of generating the next MW to supply load at a specific location (based on marginal generation cost), the cost of transmission congestion, and the cost of losses. = Generation Marginal Cost LMP Transmission Congestion Cost + *For the sake of simplicity, this presentation does not discuss losses or include their costs in its calculations. LMP Basics

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zLets make it simple: Under the Locational Marginal Pricing methodology, the LMP at Node B will be the bid price of the Node A generator that supplies the next MW to serve the load. zIn this example, G1 can exclusively supply the 100 MW of load, so the LMP at Node B is $20/MWh (which the load pays for its 100 MW). G1 G2 G3 Node A 100 MW Load Node B 100 MW $20/MWh $30/MWh $50/MWh 100 MW $20/MWh $2,000

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LMP Basics zIn this example, the load increases from 100 MW to 101 MW. zG1 can no longer exclusively supply the load, so G2 must be dispatched for 1 MW. zThe LMP at Node B is now $30/MWh. zThe load now pays $30/MWh for all 101 MW, and both G1 and G2 receive $30/MWh their generated energy. G1 G2 G3 Node A 100 MW Load Node B 101 MW $20/MWh $30/MWh $50/MWh 100 MW 1 MW $30/MWh $3,030 ($1,030 for the next MW of load)

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LMP Basics zThe LMP at Node B is now $50/MWh, because the next MW used to meet the load is generated by G3. zThe load pays $50/MWh for all 201 MW, and G1, G2, and G3 all receive $50/MWh their generated energy. G1 G2 G3 Node A 100 MW Load Node B 201 MW $20/MWh $30/MWh $50/MWh 100 MW 1 MW $50/MWh $10,050 ($4,050 for the next MW of load)

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LMP Basics zUnder the conditions in the preceding example, if G3s bid is $100/MWh, the load would pay a total of $20,100 ($14,100 for next MW of load). zIf G3s bid is $200/MWh, the load would pay a total of $40,200 ($34,200 for the next MW of load). G1 G2 G3 Node A 100 MW Load Node B 201 MW $20/MWh $30/MWh $?/MWh 100 MW 1 MW $?/MWh

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17 Security-Constrained Dispatch Examples zBefore we begin the next set of examples, remember three simple but very important concepts: yThe LMP at a load is usually, but not always, equal to the bid price of the next MW generated to meet that load. yWhen the transmission system is unconstrained, the LMPs are equal at all nodes to the bid price of the next MW generated to meet that load. yUnder constrained conditions, LMPs vary by node and can be higher than any generator bid. zNote: The load and the generator capabilities and dispatches will vary from example to example, but the generator bid prices remain the same throughout.

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Security-Constrained Dispatch Examples The following are some relatively simple examples of how LMP prices are calculated from the security-constrained dispatch of a simple transmission system, given the market participants bids. Note: All lines have equal impedance. Generator A bid = $30/MWh Generator B bid = $20/MWh C B A 15 MW limit Load

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19 Unconstrained Dispatch Examples zIn these next two examples, an increase in load does not cause transmission congestion, so: yThe lowest-bid generator can be used to meet the load, assuming that the generator is capable of doing so. yRedispatch is not necessary to serve the load. yAll requests for transmission to serve the load from the lowest- bid generator can be accommodated.

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Unconstrained Dispatch Examples zIf the load on this system were 15 MW at Node C, and Generator B is capable of generating at least 15 MW: yGenerator B is the exclusive supplier, and flow on the line B-C is 10 MW, below the 15 MW limit, because two-thirds of the energy injected at B flows to C on the B-C line and one-third of the energy flows on the B-A and A-C lines. yNo resultant congestion, and LMP at the load would be $20/MWh. 15 MW Note: All lines have equal impedance. 5 MW 10 MW 5 MW 15 MW limit Generator A bid = $30/MWh Generator B bid = $20/MWh C B A

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22 Constrained Dispatch Examples zIn this next example, the load at Node C increases to the point that supplying it results in a transmission constraint, so: yThe lowest-bid generator (Generator B) cannot be exclusively used to meet the load, because doing so would violate the constraint. yOut-of-merit redispatch of the other, higher-bid generator (Generator A) is necessary to serve the load, and LMP at the load is calculated based on the redispatch costs.

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Constrained Dispatch Example zFrom the preceding example, if the load increases from 21 MW to 30 MW, even if Generator B were capable of exclusively supplying the entire load, it could not do so without exceeding the limit on line B-C. zIn order to not exceed the constraint, redispatch would need to be performed so that Generator A is incremented by 12 MW (to 15 MW) and Generator B is decremented by 3 MW (to 15 MW). 15 MW (-3) 30 MW (+9) Note: All lines have equal impedance. 5 MW 10 MW 5 MW 15 MW limit Generator A bid = $30/MWh Generator B bid = $20/MWh C B A 15 MW (+12) 5 MW 10 MW 5 MW

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LMP Price Derivation at Node A zIn this new unconstrained example, a load at Node A would pay an LMP of $20/MWh, since that load can be met by dispatching Generator B. This is due to the fact that Generator B can serve the load at Node A without violating the constraint MW 15 MW Note: All lines have equal impedance. 5 MW 10 MW 5 MW 15 MW limit Generator A bid = $30/MWh Generator B bid = $20/MWh C B A 1 MW load 0.67 MW 0.33 MW

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LMP Price Derivation at Node A zIn this new constrained example, a load at Node A would pay an LMP of $30/MWh, since that load can only be met by dispatching Generator A. This is due to the fact that Generator B cannot serve the load at Node A, because part of the energy would flow across line B-C and violate the constraint. 15 MW 30 MW Note: All lines have equal impedance. 5 MW 10 MW 5 MW 15 MW limit Generator A bid = $30/MWh Generator B bid = $20/MWh C B A 5 MW 10 MW 5 MW 1 MW load MW

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LMP Price Derivation at Node B zIn this new unconstrained example, a load at Node B would pay an LMP of $20/MWh, since that load can be met by dispatching Generator B (within the capability of the generator). zThis LMP would apply even if the system were constrained, and is only subject to the capability limit of Generator B MW 15 MW Note: All lines have equal impedance. 5 MW 10 MW 5 MW 15 MW limit Generator A bid = $30/MWh Generator B bid = $20/MWh C B A 1 MW load

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29 LMP Price Derivation Summary zLMP prices are based on actual flow of energy and system operating conditions. zThe LMP at a load is usually, but not always, equal to the bid price of the next MW generated to meet that load. zWhen the transmission system is unconstrained, the LMPs are equal at all nodes to the bid price of the next MW generated to meet that load. zUnder constrained conditions, LMPs vary by node and can be higher than any generator bid. zNodal LMPs are a direct function of the systems constraints.

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34 Who Will Be Affected By LMP? zIf FERC has its proposed way, the entire United States will be under an LMP market by October 2004 (through the Standard Market Design NOPR). zAs it stands now, the California ISO plans to implement an LMP-based market (known as MD02) on or around October zInformation regarding the ISOs effort can be found at html

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35 Who Will Be Affected By LMP? zIn addition, the Midwest and SPP ISOs plan to jointly implement an LMP-based market on or around December zThis implementation will accomplished through adoption and (eventually) seamless integration of the PJM ISOs LMP-based market. zInformation regarding this effort (referred to as the Midwest Common Market Initiative) can be found at 02_Filing.pdf

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36 Various Arguments Against LMP zLack of pricing transparency: LMPs after-the-fact pricing provides no transparency to buyers. zHigh transaction costs: Even relatively small electrical systems such as the PJM or New York ISOs can have thousands of nodes, and the resulting multiple nodal transaction costs can limit market participation and entry. zRegulated and unregulated services are needlessly bundled: Under LMP, transmission (a regulated service) is effectively bundled with the generation commodity (unregulated market) in order to derive prices.

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37 Various Arguments Against LMP zLMP improperly allocates risk: The requirement that all successful bidders receive the highest bid price improperly allocates risk and is unnecessarily lucrative to suppliers. zLMP is subject to market power abuse: LMP becomes subject to market power abuse if a horizontal concentration in generation is capable of manipulating the exchange price. zLMP does not provide incentive to construct generation or transmission: LMP may in certain instances provide incentive to avoid the construction of generation or transmission in order to maximize congestion revenue.